PEP’s sums not Spotless: $100m error

The error shows that Spotless chairman Peter Smedley, who fought hard to generate maximum value for shareholders during a heated battle with PEP, was successful in this regard.
Photo: Michael Clayton-Jones

Australia’s biggest private equity group, Pacific Equity Partners, has made an error in calculating the money required to run cleaning and coathanger company Spotless Group.

PEP, which took over Spotless in a $723 million deal after a bitter nine-month battle in August, was left to make up a shortfall of at least $100 million in costs after miscalculating the company’s working capital requirements.

A delayed payment by one big customer and settlement of the deal on the day that Spotless pays its 40,000 employees left PEP unable to cover all costs earlier this month. It is understood there were also issues with the total cost of paying off Spotless’s US private placement investors.

PEP was forced to ask its lenders, including Australia’s big four banks, Japan’s Sumitomo Mitsui, HSBC, Deutsche Bank, and Citigroup to extend extra funds earlier than expected from its multimillion-dollar debt facility. The banks extended $100 million in credit and agreed to increase the working capital facilities by about $35 million.

The error shows that Spotless chairman Peter Smedley, who fought hard to generate maximum value for shareholders during a heated battle with PEP, was successful in this regard. Sources said the mistake boosted the value for shareholders by more than 50¢. PEP’s advisers on the deal were Citigroup, Investec and accounting firm PwC.

It is understood Spotless directors were aware of the working capital issue. They had asked PEP for indemnity in relation to several general concerns the private equity group had raised between when the deal was signed on July 27 and completed on August 15. However, PEP did not grant indemnity.

Industry sources speculated PEP had also been required to tip in up to $100 million in extra equity to help make up the shortfall in the cost funding – a move that would threaten its returns from the deal.

But in an emailed statement last night PEP managing director and new Spotless board member Anthony Kerwick said: “The assertions that you have put to us on changes to the capital structure, including the equity component of this transaction, are incorrect. PEP is pleased to have closed the Spotless deal last week and is happy with the funding structure and financing agreements it has in place. There has been no major deviation from our expectations.”

PwC said: “This is a client matter and PwC does not comment on matters regarding our clients.”

Sources last night said the hostile nature of the takeover had hurt PEP in its due diligence process. The Spotless board and PEP reached a $2.71 a share agreement on April 30 after more than five months that included a dispute between the target and shareholders and intense negotiations just to agree to due diligence.

The deal offered $2.62 cash a share, plus a 4¢ special dividend franked to 95 per cent. It also included a 5¢ dividend already paid to shareholders by Spotless.PEP conducted due diligence for 65 days from the day of approval to the date of the agreement. Spotless shareholders voted overwhelmingly for the scheme of arrangement on July 25 and received approval from the Supreme Court of Victoria two days later. Spotless shares were transferred to PEP subsidiary Pacific Industrial Services BidCo on 16 August and all Spotless directors resigned the same day. Spotless was delisted on 17 August.

Since PEP has taken control of Spotless, the beleaguered coathanger business Braiform, which was a stumbling block during bid negotiations, has been carved out of the existing business and now reports directly to PEP. The coathanger division once generated more than a third of total earnings but gradually lost earnings when retailers struggled as consumers spent less.

The bulk of the Spotless business, which includes facility management, cleaning services and maintenance services, continues to trade as normal under the guise of newly appointed chief executive Bruce Dixon.

Spotless operates in 30 countries and turns over $2.8 billion annually. The group includes more than 40,000 staff.

In an interview with The Australian Financial Review, newly appointed chief executive Bruce Dixon said his focus was on reducing overheads and reconnecting with clients. He also implied the previous Spotless management’s “Rolls Royce” technology upgrade would be scaled back.

In its management presentation to PEP at the end of 2011, Spotless said the group’s ability to manage and optimise working capital would be improved by investing in the business and IT platform. Spotless said that after the group had fully integrated the new platform, normal working capital investment would be required as revenues grew over the medium term.